China’s $9 trillion moral hazard is now too big to ignore

China may be about to embark on its most ambitious — and perilous — campaign to convince investors that they shouldn’t depend on a bailout when markets go south.

In a rare show of cooperation, the nation’s main financial regulators are drafting new rules for asset-management products that aim to make clear the investments don’t have government guarantees, people familiar with the matter told Bloomberg News on Tuesday.

The products, which promise higher returns than bank deposits but are viewed by many investors as a form of risk-free savings, have become an integral part of the Chinese financial system after swelling in recent years to almost $9 trillion as of June 30.

Policy makers face a difficult balancing act. If they fail to dispel the notion of an implicit government guarantee, riskier investments could proliferate and pose an even greater threat to the financial system when China faces its next bout of market turmoil. But if authorities act too forcefully now, they risk triggering a stampede away from products that have become a key funding source for banks. …